Mar 2013 - Conspiracies?

GOLD - the latest conspiracy theory - China ?

Gold has passed through various conspiracies holding it back such as the central banks (who famously once stated at a conference in Kalgoorlie that "we control the gold price"), and repeatedly announced that they were selling, together with encouraging hedging which was akin to pouring oil on troubled water or basically removing the volatility.

It should be noted that this column has been based purely on observation, not on economic theory, and that many of the figures and numbers quoted have been sourced from the "China Daily".

Despite the US printing money, the gold price has drifted sideways, and gradually weakened to under US$1600/oz on a stronger US$. Or at least it did until almost all the banks and brokers went seriously negative, in some cases reducing their 3 to 12 month forecasts by up to US$250/oz, and the gold price then suddenly rose by ~$50/oz within a few days to ~US$1615/oz on 27 February 2013, before dropping back again.

We have seen this pattern more than once before, when the banks/brokers go seriously negative and the gold price suddenly rises. Gold has a habit of being contrarian, when the banks/brokers/media are positive with higher forecasts, often the gold price falls, and vice versa it rises when almost everyone becomes negative.

One of the past times of note that the gold price suddenly reversed was described in our Goode News Paydirt column submission of November 2008 (eagleres.com.au/paydirt/item/nov-2008-understanding-gold), in which we wrote of "two major brokers forecasting the gold price to collapse and average (according to one of them) to an average of US$690/oz for DQ08 and US$630/oz for MQ09, the scene was set for a sudden rise, which occurred almost the next day with a $50/oz jump in the gold price on Friday 21 November 2008".

That forecast of ~US$630/oz for MQ09 was then expected to weaken further. Whereas instead about 4 years' later, its current trading price is ~$1000/oz higher than that forecast, but that is one of the main difficulties with trying to accurately forecast the gold price.

The markets do appear to enjoy downplaying gold, and despite short term increases, most brokers have the gold price falling to long-term levels of US$1200/oz to US$1400/oz. Perhaps cynically, more brokerage can be made in a negative gold price scenario, amongst the myriad of industrial stocks.

The current weakness and expected further weakness has been attributed to expectations of a stronger US$ and the gold ETFs (exchange traded funds) reducing their holdings from the total held at the end of Ferbruary 2013 of ~2510t of gold.

The US$ is obviously popular as an alternative to the Euro and GBP(ound), but is it that simple? Historically, countries that have printed money have had their currency values deteriorate significantly as seen in post war Germany, Zambia and Zimbabwe, where wheelbarrows of a collapsing valued paper currency were used to buy items.

Gold pundits expected the gold price to rise on the back of a weak US$, due to the printing machines churning out US$, but that has not happened. Possibly because the comparisons were drawn with historical countries that had very low GDPs (gross domestic products). The US' GDP in 2012 was apparently ~$15.7trn, or more than double that of China's $8.1trn, or is the drifting gold price and relatively strong US$ partly due to China ?

The US' M2 was $10.5trn in 2012 compared to China's $15.5trn. But the US Gross debt/GDP was 110.2% in 2012 (or $17.3trn...other figures quote ~$16trn as the US debt, but possibly China's calculation methods are more conservative), compared to China's 26.4%, (or $2.14trn) and China expects their gross debt to GDP to fall to ~24% in 2014 (having peaked at 33.5% in 2010).

China is regarded as the highest country holder outside the US of US TB's (treasury bonds) with ~$1.2trn, being 36.4% of China's forex reserves of $3.31trn. During the past year, China increased its holding of US TB's by $77bn of which $19.7bn occurred in December 2012, thereby supporting the US$.

The rationale in having such a high holding in US$ may be two-fold, being the growing acceptance of the Rmb or Yuan as a freely acceptable tradeable foreign reserve currency; and if the US$ does not collapse, then the gold price does not "take-off" and China can then increase its gold holdings at reasonable levels. Quite simply, it does not appear to be in China's interests to allow the US$ to collapse.

China does appear to be using its US$ holdings to barter trade projects, but otherwise it appears to be still supporting the US$.

In 2012, China's gold production was 403.1t or up 42.1t (11.7%) on 2011's production, with 341.8t from its mines and 61.3t from by-product gold. To which can be added the 834.5t of gold officially imported through Hong Kong in 2012 (compared to the 431.2t imported in 2011).

Just how much has been added to China's gold holdings is anyone's guess, but if China's aim is to become the reserve currency of the world, then it appears likely to need a sizeable gold holding.

At the end of December 2012, the total gold holdings (according to the WGC [World Gold Council]) of the CBs (Central Banks) was ~31,600t of gold of which the top 4 major holders had >70% of their reserves in gold, being the US (8,134t), Germany (3,391t), Italy (2,452t) and France (2,435t), with the IMF holding 2,814t.

The next group of major holders includes Switzerland with 1040t (11%), and Russia at 958t (9%). Although the UK has only 310t, that is 16% of its reserve. Turkey also had 16% of its reserves in gold with its holding of 360t at the end of 2012.

The US recently completed an internal audit of the NY Fed Reserve stating that it had 13.88moz in gold bars and 0.074moz in gold coins (or 432t of gold) for a value of $568m or based on a gold price of $41/oz which has already drawn criticism as it excludes Fort Knox and other depositaries plus does not detail what gold the US holds on behalf of other countries.

China has 1054t of gold representing only 2% of its reserves (according to its last announcement in 2009). If China decides that it needs to have ~10% of its reserves in gold, then it needs to acquire another ~4,000t of gold, and may have already acquired some of that.

The difficulty with the supply and demand of gold table is that it is balanced after the figures come in. So if China has bought say 1000t of gold which is currently not shown in the supply/demand table, then the table has to be readjusted afterwards, using balancing numbers. Or to put it another way, the supply and demand balance of gold is simply a guideline, and forecasts are open to debate.

The CBs have been steadily buying gold to ostensibly re-diversify their asset base. Although China has not declared how much gold it has acquired during 2012, the other world CB's added 534.6t in 2012 (apparently the highest net purchase since 1964) and consequently almost reversed their 3-year sale of 1143t up to JQ2009 (when they switched to net purchases), through buying ~1100t by the end of 2012.

However, some of the material holders have changed such as Turkey with its 165t net purchase from 195t in 2011 to 359.6t at the end of 2012, and are still buying as in another 10.3t in January 2013. Russia's CB bought 12.2t in January increasing its holding to 970t of gold, following its purchase of 75t during 2012.

It seems doubtful that so many CBs are buying gold now because they expect the gold price to fall. After all if the banks and brokers are correct in their forecasts then the gold price could be under $1500/oz by the end of 2014, or perhaps it is the possibility that like the end of 2008 when the gold price was forecast to gradually fall below US$600/oz, the gold price could just as easily be much higher by the end of 2014.

In April 2012, India was forecast to reduce its gold imports by 38% or ~360t during 2012 from the 957t of 2011, due to a tax hike, but actually only reduced them by ~100t down to 860t in 2012. The WGC apparently expects that to reverse and reach 965t in 2013, despite expecting further curbs from the Indian Govt (because gold imports account for ~80% of India's current account deficit).

However, in its latest budget the Indian Govt actually did not increase import duties, instead stating that they intend to make their financial instruments more attractive and encourage higher savings to reduce the attractiveness of gold.

More than all of the gold imported by India appears to be consumed as in the 864t of demand in 2012, compared to the 860t imported. And in January 2013, India imported almost 100t of gold, ahead of those anticipated further import restrictions.

One report we recently read, pointed out that China's gold demand was disappointingly weak in 2012, following the ~20%pa increases that had occurred in 2010 and 2011, showing demand almost unchanged at about 800t in 2012. Clearly there must be some other statistics as China's gold imports through Hong Kong have been reported as almost trebling from 119t in 2010 to 431t in 2011, and then almost doubling to 835t in 2012 !

At the last China Mining Conference held in Tianjin in November 2012, it was remarked "why should we (China) have to pay high commodity prices for our own growth, the prices are only high because of our demand".

It was also commented that "we (China) have so far been given two gifts to acquire resources cheaply, namely the GFC in 2008, and the current Euro crisis". They were crises for the world, but actually gifts from a Chinese perspective.

So could China be trying to manipulate the gold price lower in order to increase its gold holdings? - maybe.

The gold price (along with other commodities) recently fell on the basis of a rumour that a major hedge fund had collapsed and was being liquidated. We have had oversupply rumours and rumours that China has excess stockpiles etc etc in nickel, steel and iron ore that have resulted in commodity prices falling significantly. Only to encounter major buying from China (as witnessed by that rebound in iron ore prices in late 2012).

It is possible that some dampening of the gold price may be associated with China. And when China has acquired its required gold holding, it may not want the gold price to then collapse, perhaps instead ideally having a sideways drifting gold price about a perceived level.

At that China Mining Conference in November 2012, the gold price was expected to be flat during 2013 at about US$1700/oz.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is a Financial Services Representative with Taylor Collison Ltd.